We need more investment to make the most of the recovery

Capital will not be coming from high street banks. We need to make life as
easy as we can for those who do want to offer it.

Business investment will be crucial to the recoveryPhoto: PA

By Tim Hames

10:09PM GMT 12 Jan 2014

For patients with medical difficulties, the early stages of a recovery can be as risky as the initial hours after trauma first strikes.

The body has adapted to one shock but further lesser ones can be fatal. Complications set in and derail initial progress. There is the risk of internal and external infection.

Few doctors would rush to pronounce a patient who had endured a coronary or a similar massive mishap cured simply on the basis of a relatively short period of recuperation. They would instead warn that the really hard work of ensuring a long-term return to health had merely started.

The same is true for small and medium-sized businesses in Britain at the moment. In most parts of the United Kingdom, local economic conditions are clearly better today than they were 12 months ago, but there is a huge amount of regional disparity in that assessment.

Commentators have, though, at least moved on from discussing whether or not there would be a recovery at all in the UK to whether or not the recovery which we think has taken hold is the “right” or the “wrong” sort (although there will be many a struggling small business for which this debate is interesting but irrelevant).

Yet the blunt truth is that for many small businesses the next six months will be as crucial to their future prospects as the six years of ceaseless slog that we hope to have placed behind us.

This is for two reasons related to access to finance.

The first is the fear, based on the experience of the aftermath of recessions in the 1970s, 1980s and 1990s, that the early stage of a recovery is when creditors (particularly banks) choose to pull the plug on small firms whom they carried on backing during the downturn because they knew that if they foreclosed on them, then they would not make anything at all from the sale of their assets.

Anecdotal evidence, but in ample amounts, suggests that just as the Spanish flu of 1918-1920 apparently killed more unfortunate souls than the Great War which had preceded it, so the six months after a recovery has been declared might again witness the silent slaughter of businesses which have made it through far tougher economic conditions, but which it is now practical to dispose of quietly.

In this regard, however, I am an optimist. I do not think that the behaviour of the 1970s, 1980s and 1990s can be repeated today in a country where the state is a far larger shareholder and wider stakeholder in the banking sector than it was on those previous occasions.

I also doubt whether media outlets, such as this newspaper, would allow such economic eugenics to occur without enormous and vastly adverse publicity. The corporate Grim Reaper may be disappointed this time.

The second threat is the more disturbing. It is that companies who can see new customers, markets and orders on the horizon as the economy acquires momentum do not receive the investment that they urgently need to allow them to make the most of this opportunity.

Bank lending to SMEs fell in 2013, despite it being a better year for the economy than 2012 or 2011. If this happens again, then what should be a reasonably vigorous recovery might yet relapse.

The risk of this is very real indeed. Nothing has changed in terms of the enhanced capital requirements and the cultural transformation within the high street banks since 2008 which will lead them to offer lending in proportion to a strengthening economy.

Many of the institutions, especially those based in Iceland and Ireland, which were most willing to open chequebooks in 2005-2007 are in no position to do this again, because they no longer exist themselves.

Until now, the banks have had a defence to the charge that they are “not lending” to SMEs, namely that small companies are not asking for such capital. I doubt that such a defence will still be valid by the end of 2014.

What we need to do instead is champion alternative sources of support for smaller companies. Some 90pc of private equity transactions, for example, involve SMEs and almost 100pc of venture capital investments travel in that direction. British business needs more of this backing.

One case illustrates this perfectly. Enterprise Ventures (EV), a Manchester-based venture capital firm, last year injected £29m into 211 investments in businesses with considerable growth potential. Over three years, it has placed £73m in an astonishing 555 transactions, or almost one per working day.

The clear majority of these have been in earlier-stage enterprises (those with a turnover of less than £10m), which certain banks would automatically discount from their lending strategies. Yet these are precisely the type of companies that the United Kingdom needs to see thrive.

Although EV will look at most propositions, its speciality is often the application of new technology to old challenges, in a wide variety of situations. It has backed Tyres on the Drive, a business that allows the haulage industry to book to have tyres fitted at a place and time of its convenience.

It put £860,000 into Xeros, a company that has developed a washing machine using polymer beads which consumes up to 80pc fewer resources than conventional systems. Based on technology originally devised at Leeds University, this has a vast export potential.

EV recently supported FDM Digital, a start-up which uses the latest 3D printing techniques to make insoles to enable the NHS to treat patients with foot injuries. This breakthrough could revolutionise the supply chain for the health service in this area, with immensely positive implications for cost savings.

This is an exceedingly rare example of the NHS working with a very new business rather than choosing an older, but perhaps less innovative, provider. It cannot be stressed enough how unlikely it is that such companies would have been embraced by “mainstream” financial institutions.

Recovery is, naturally, better than recession. Yet recovery comes with risks. In this case, it is that insufficient capital is mobilised to support ambitious businesses. That money will not be coming from high street banks. We need to make life as easy as we can for those who do want to offer it.

Tim Hames is director general of the British Private Equity and Venture Capital Association (BVCA)